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IAI Actuarial Core Principles · Business Economics · Importance of international trade

Country X's domestic opportunity cost is 2 units of steel per unit of tea. Country Y's is 4 units of steel per unit of tea. Which international exchange rate (units of steel per unit of tea) would allow both countries to gain from trade?

The exchange rate of 3 units of steel per unit of tea works. Country X, the tea exporter, has an opportunity cost of 2 and Y has 4, so a price strictly between 2 and 4 lets both gain. At the endpoints one side gains nothing.

  1. A1.5
  2. B2.0
  3. C3.0Correct
  4. D4.0
  5. 5.0

Explanation

X has the lower opportunity cost of tea, so it exports tea and Y exports steel. A mutually beneficial price must lie strictly between 2 and 4 steel per tea. Only 3.0 qualifies. At 2.0 X gains nothing and at 4.0 Y gains nothing; 1.5 and 5.0 are outside the range and one country would refuse to trade.

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